Taxpayer Seeks Rehearing En Banc in Historic Boardwalk

The taxpayer has filed a petition for rehearing and rehearing en banc in Historic Boardwalk, asking the Third Circuit to reconsider its decision denying the taxpayer’s claim for historic rehabilitation credits.  Among other points, the petition criticizes the panel’s decision for analogizing this case to the Second Circuit’s Castle Harbour decision, TIFD III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006), which found that the partner there had no downside risk that it would not recover its capital contribution.  The taxpayer argues that there was a risk here that the partner would not recover its capital contribution from the partnership, and the court erred in finding that there was no risk by taking the tax credits into account.  Specifically, the petition argues, “the Opinion wrongfully treats the allocation of the historic rehabilitation tax credits to [the investor] by operation of law (i.e., under the Code) as a repayment of capital to” the investor by the partnership.

There is no due date for a response by the government.  Under Rules 35 and 40 of the Federal Rules of Appellate Procedure, a party is prohibited from responding to a petition for rehearing unless it is directed to do so by the court.

Historic Boardwalk – rehearing petition

Tax Court Reversed on Historic Rehabilitation Credits in Historic Boardwalk

[Note:  Miller & Chevalier filed a brief in this case on behalf of National Trust for Historic Preservation]

In a detailed 85-page opinion, the Third Circuit has reversed the Tax Court’s opinion that upheld a claim for historic rehabilitation tax credits by the private partner in a public/private partnership that rehabilitated a historic property on the Atlantic City boardwalk.  See our earlier report here.  The government had argued both that the transaction lacked economic substance and that the private partner, Pitney Bowes, was not a bona fide partner in the enterprise.  The Third Circuit agreed with the government’s second argument and therefore found it unnecessary to decide whether there was economic substance.  Given that approach, the court stated that it would “not opine on the parties’ dispute” on whether the Ninth Circuit was correct in Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995), in stating that the policy of providing a rehabilitation credit as a tax incentive is relevant “in evaluating whether a transaction has economic substance.”  Slip op. 54 n.50.  The court did make some general observations on economic substance, however, noting its agreement with amicus that the government’s position had inappropriately blurred the line between economic substance and the substance-over-form doctrine, which are “distinct” doctrines.  Slip op. 52 n.50.  Citing Southgate Master Fund, L.L.C. v. United States, 659 F.3d 466, 484 (5th Cir. 2011), the court added that “even if a transaction has economic substance, the tax treatment of those engaged in the transaction is still subject to a substance-over-form inquiry to determine whether a party was a bona fide partner in the business engaged in the transaction.”  Slip op. 53 n.50.

Turning to the issue that it found dispositive, the court concluded that Pitney Bowes was not a bona fide partner because it “lacked a meaningful stake in either the success or failure of [the partnership].”  Slip op. 85.  In reaching that conclusion, the court relied heavily on two recent court of appeals’ decisions, the Second Circuit’s analysis of bona fide equity partnership participation in TIFD III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006) (“Castle Harbour”) and the Fourth Circuit’s analysis of “disguised sales” in Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011).  Although the taxpayer had objected that the latter case was irrelevant because no disguised sale issue was present, the court agreed with the government’s argument in its reply brief that “the disguised-sale analysis in that case ‘touches on the same risk-reward analysis that lies at the heart of the bona fide-partner determination.’”  Slip op. 67 n.54 (quoting U.S. Reply Br. 9).  See our previous report here.  The court elaborated on this point as follows:  “Although we are not suggesting that a disguised-sale determination and a bona fide-partner inquiry are interchangeable, the analysis pertinent to each look to whether the putative partner is subject to meaningful risks of partnership operations before that partner receives the benefits which may flow from that enterprise.”  Id. at 69 n.54.

The taxpayer had relied heavily on the Tax Court’s findings regarding the essentially factbound question of bona fide partnership, but the Third Circuit found that the deferential standard of review of factual findings was not an obstacle to reversal.  The court first stated that “the record belies” the Tax Court’s conclusion that Pitney Bowes faced a risk that the rehabilitation would not be completed.  Id. at 73.  To deal with the standard of review, the court of appeals drew a hair-splitting distinction between the factual issue of “the existence of a risk” and what the court believed to be a “purely . . . legal question of how the parties agreed to divide that risk,” which “depends on the . . . documents and hence is a question of law.”  Id. at 73 n.57.  The court of appeals directly rejected other Tax Court findings regarding risk as “clearly erroneous.”  Id. at 76.

The court did not dwell on the policy implications of its decision.  It stated that it was “mindful of Congress’s goal of encouraging rehabilitation of historic buildings” and had not ignored the concerns expressed by the amici that a ruling for the government could “jeopardize the viability of future historic rehabilitation projects.”  Id. at 84.  But the court brushed aside those concerns, taking comfort in the response of the government’s reply brief that “[i]t is the prohibited sale of tax credits, not the tax credit provision itself, that the IRS has challenged.”  Id. at 85.  Be that as it may, decisions like this are likely to diminish the practical effectiveness of the credit as an incentive and thus to frustrate to some extent Congress’s desire to encourage historic rehabilitation projects.

A petition for rehearing would be due on October 11.

Historic Boardwalk – Third Circuit Opinion

Third Circuit Panel Announced for Historic Boardwalk Oral Argument

[Note:  Miller & Chevalier represents amicus National Trust for Historic Preservation in this case.]

The Third Circuit has scheduled oral argument in the Historic Boardwalk case for June 25 in Philadelphia.  (The argument previously had been tentatively scheduled for April, but was postponed.)  The panel will consist of Judges Sloviter, Chagares, and Jordan.

Bush TEFRA Claims Whacked for the Final Time

Long-time readers of the blog may recall our coverage of the Federal Circuit’s stumbles through TEFRA in the Bush litigation, where a panel issued a surprising decision finding that a notice of deficiency was required to make what was previously understood as a mere TEFRA computational adjustment, but that the IRS’s failure to issue the notice was harmless error.  Both sides cried foul, and the en banc court overturned the panel’s decision.  The Supreme Court this morning today denied the taxpayers’ petition for certiorari, meaning that the case has reached the end of the line, which turns out to be pretty much where the Court of Federal Claims put the case in the first place.

NPR Oral Argument

On December 7th, oral argument was held in the Fifth Circuit in the NPR case before Judges Dennis, Clement, and Owen.  You can find a detailed explanation of the issues here but in summary the questions involve whether, in the context of a Son of BOSS case: the gross valuation penalty applies when the basis producing transaction is not invalidated solely due to a bad valuation; whether other penalties apply; how the TEFRA jurisdictional rules function as to those penalties; and whether an FPAA issued after a non-TEFRA partnership no-change letter falls afoul of the no-second-FPAA rule. 

Although both parties appealed, as the initial appellant DOJ began the argument.  DOJ counsel argued that the Supreme Court’s decision in Nat’l Cable & Telecomm. Ass’n v. Brand X Internet Servs., 545 U.S. 967, 982 (2005), allowed Treas. Reg. § 1.6662-5(d) to override the Fifth Circuit’s position in Heasley v. Commissioner, 902 F.2d 380 (5th Cir. 1990), that a valuation misstatement cannot apply where there are grounds for invalidating the transaction other than an incorrect valuation — such as where the transaction is totally disallowed under economic substance or on technical grounds.  In this regard, DOJ requested that the court submit the matter for en banc review to address this issue and to consider the impact of Weiner v. United States, 389 F.3d 152 (5th Cir. 2004), which counsel characterized (as DOJ had in the brief) as calling the “total disallowance” rule into question. 

As to the substantive application of penalties, DOJ argued that the complete concession by the taxpayer of the substance of the transaction compelled the conclusion that the position lacked substantial authority.  Furthermore, counsel argued that there was no substantial authority at the time the transaction was reported on the taxpayer’s return.  In this regard, DOJ posited that although Helmer v. Commissioner, 34 T.C.M. (CCH) 727 (1975), had held that a contingent liability was not a liability for purposes of section 752, it did not address the questions of buying and selling offsetting options and of contributing them to a partnership only to arrange for a distribution and sale.  As to these points, the only authority on point was Notice 2000-44, which stood for the proposition that the transaction did not work.  This appears to be a repackaged version of the argument that there can never be substantial authority for transactions lacking economic substance. 

Argument transitioned to the question of whether the district court had jurisdiction to consider a penalty defense put on by the partners and not by the partnership in this partnership action.  For a prior discussion of this confusing question see our analysis here.  Citing Klamath Strategic Inv. Fund, LLC v. United States, 568 F.3d 537 (5th Cir. 2009), DOJ counsel argued that the Fifth Circuit had already decided that an individual reasonable cause argument (such as one based on a legal opinion issued to the partner) cannot be raised in a TEFRA proceeding.  The court seemed to recognize the impact of Klamath on this point.  DOJ counsel then attempted to box the partnership in (as it had in the brief) on the question of whether the defense was raised by the partner or the partnership (several statements in the district court’s opinion seem to view the defense as a partner-level defense).  

Moving on to the question of the merits of the reasonable cause position, DOJ argued that the district court erred in considering reliance on the tax opinion (which was written by R.J. Ruble) to be reasonable.  Initially, counsel questioned whether the partners’ testimony that they did not believe Ruble had a conflict was reasonable in light of the partners’ knowledge of fee sharing and of the fact that Ruble had written opinions for other shelters for the same promoter.  The court seemed to be honed in on this question.  In closing, DOJ attempted to poison the well of partner good faith by reminding the Court that the partners in this case were repeat tax-shelter offenders and had attempted to hide the Son-of-BOSS losses as negative gross revenue from their law firm business. 

Perhaps indicating a weakness on the penalty issues raised by DOJ, taxpayer’s counsel spent most of his time on the question of whether the second FPAA was invalid.  The Court focused counsel on the fact that an error on the tax return (the Form 1065 did not check the TEFRA box although it did check the flow-through partner box (which would indicate a TEFRA partnership)) led the agent originally to pursue the case as non-TEFRA.  Undeterred, counsel argued that this error was not material and that the agent had indicated in a deposition that he eventually learned that the partnership was TEFRA.  Testimony was also offered in the district court that the reporting was an innocent mistake and not negligent or deceptive.  The Court spent significant time questioning why the agent did not testify at trial (which appears to have been due to a mix-up on the part of DOJ).  In summarizing his position, taxpayer’s counsel tried to focus the court on the language of the partnership no-change letter but to us it appears that the real question has to be whether the agent intended this to be a TEFRA audit.  An FPAA simply cannot come out of a non-TEFRA audit.  Based on the agent’s deposition transcript it seems clear that he did not believe he was involved in a TEFRA audit when he opened the audit and thus it is impossible that the initial notice was an FPAA. 

Rebutting DOJ’s reasonable cause position, taxpayer’s counsel focused on the trial testimony and factual determinations by the district court that the taxpayers were acting reasonably and in good faith.  On the question of jurisdiction, the taxpayer reverted to the tried and true (but not very strong) argument that requiring a later refund suit to address the reasonable cause question would be a waste of judicial resources and, in essence, a meaningless step.  A cynic might say that the purpose of TEFRA is to waste judicial resources and create meaningless steps. 

In rebuttal, DOJ counsel focused on the no-second-FPAA question and did a good job from our perspective.  He noted that you have to have a TEFRA proceeding to have a TEFRA notice.  Undermining the district court’s determination that the finality of the notice is relevant, counsel noted that all non-TEFRA notices are “final” but that doesn’t mean they are FPAAs.  TEFRA is a parallel audit procedure and it is simply not enough that the IRS intended a final determination in a non-TEFRA partnership audit.  The question is whether the IRS intended to issue a final notice in a TEFRA proceeding; since there was no “first” TEFRA proceeding, there was no “first” FPAA.  We think this argument is right on target. 

With limited questions coming from the Court it is difficult to see where this is headed.  Our best guess is that the partnership will prevail on the reasonable cause position (it is difficult for an appellate court to overturn credibility determinations of witnesses) but lose on everything else including the no-second-FPAA issue.

Briefing Completed and Oral Argument Set in Historic Boardwalk Case

[Note:  Miller and Chevalier represents amicus National Trust for Historic Preservation in this case]

The government has filed its reply brief in the Historic Boardwalk case in the Third Circuit.   (See our prior report and the other briefs here.)  The brief mostly goes over the same ground as the opening brief in seeking to deny section 47 historic rehabilitation credits to the private investor partner in the partnership that rehabilitated East Hall on the Atlantic City boardwalk.  It attempts to side-step the Ninth Circuit’s economic substance analysis in Sacks by arguing that the Third Circuit did not explicitly endorse Sacks when it distinguished that case in other decisions.  The brief urges the court instead to follow the Fourth Circuit’s Virginia Historic decision (see our coverage here), even though that case involved the disguised sale provisions, arguing that the case “touches on the same risk-reward analysis that lies at the heart of the bona-fide partner determination.”  The government also argues that Congress’s intent in passing section 47 would not be thwarted because the private investor allegedly “made no investment in the Hall.” 

Indeed, the reply brief includes a special “postscript” “in response to the amicus brief” filed for the National Trust for Historic Preservation that seeks to deflect the charge that the government’s position would undermine Congress’s purpose to facilitate historic rehabilitation.  Not so, says the government.  It is only “the prohibited sale of federal tax credits — not the rehabilitation tax credit provision itself — that is under attack here.”

Oral argument in the case has been tentatively scheduled for April 20.

Historic Boardwalk – Government’s Reply Brief

Third Circuit Considering Historic Rehabilitation Tax Credits in Historic Boardwalk Case

[Note:  Miller and Chevalier represents amicus National Trust for Historic Preservation in this case]

We present here a guest post by our colleague David Blair who has considerable experience in this area and authored the amicus brief in this case on behalf of the National Trust for Historic Preservation.

The government has appealed to the Third Circuit its loss before the Tax Court in Historic Boardwalk Hall, LLC v. Comm’r, which involves a public/private partnership that earned historic rehabilitation tax credits under Code section 47.  The partnership rehabilitated East Hall, which is located on the boardwalk in Atlantic City.  East Hall was completed in 1929, hosted the Miss America Pageant for many years, and is listed on the National Register of Historic Places.  The IRS sought to prevent the private partner, Pitney Bowes, from claiming the historic rehabilitation tax credits, but the Tax Court upheld the taxpayer’s position after a four-day trial.  

In its opening brief, the government advances the same three arguments in support of its disallowance that it made in the Tax Court.  First, it asserts that Pitney Bowes was not in substance a partner because it did not have a meaningful stake in the partnership under the Culbertson-Tower line of cases.  Second, it argues that the partnership was a sham for tax purposes under sham partnership and economic substance cases.  Third, it argues that the partnership did not own the historic building for tax purposes and thus was not eligible for the section 47 credits for rehabilitating the building.  In making the first two arguments, the government relies heavily on its recent victory in Virginia Historic Tax Credit Fund 2001 LP v. Comm’r, where the Fourth Circuit overturned the Tax Court and found a disguised sale of state tax credits.  (See our previous reports on that case here.)  Similarly, the government’s brief places heavy reliance on its first-round victory before the Second Circuit in TIFD III-E, Inc. v. Comm’r (Castle Harbor), which is now back up on appeal.  (See our previous reports on that case here.)  In support of its sham partnership theory, the government cites provisions in the partnership agreement that protect investors from unnecessary risks, including environmental risks.  On the third argument, the government asserts that the partnership never owned the building for tax purposes because the benefits and burdens of ownership never transferred.

Having won at trial, the taxpayer’s brief emphasizes the Tax Court’s factual findings in its favor.  It also emphasizes the historic character of the building and the Congressional policy of using the tax laws to encourage private investment to preserve this type of historic structure.  The taxpayer argues that the partnership was bona fide because the partners joined together with a business purpose of rehabilitating East Hall and earning profits going forward.  The taxpayer also argues that the partnership has economic substance.  In this regard, the taxpayer argues that the Ninth Circuit’s decision in Sacks v. Comm’r, 69 F.3d 982 (9th Cir. 1995), requires a modification of the normal economic substance analysis where Congress has offered tax credits to change taxpayers’ incentives.  The taxpayer also argues that the partnership owned East Hall for tax purposes and therefore was eligible for the section 47 credits.

The National Trust for Historic Preservation filed an amicus brief in support of the taxpayer.  That brief sets out the longstanding Congressional policy of offering the section 47 credit to encourage taxpayers to invest in historic rehabilitation projects that would not otherwise make economic sense.  It further explains that historic rehabilitation projects typically involve partnerships between developers and investors that are motivated in part by the availability of the credit.  It also is typical for these partnership agreements to protect the investors from unnecessarily taking on business risks.  The amicus brief argues that, in applying the economic substance doctrine, courts should not override the narrowly focused Congressional policy of encouraging rehabilitation projects through the section 47 credit.  Thus, courts should not simply review the non-tax business purpose and pre-tax profitability of investments in historic rehabilitation projects, but should acknowledge that the taxpayer can properly take into account the credits that Congress provides for historic rehabilitation projects.  To do otherwise, as the Ninth Circuit observed in Sacks, “takes away with the executive hand what [the government] gives with the legislative.”  The amicus argues that, at any rate, the transaction met the economic substance doctrine under Third Circuit precedent and that the partnership and Pitney Bowes interests were bona fide.  It also points out that the Virginia Historic case is inapplicable because it involved a disguised sale, which the government has not alleged in this case.  Similarly, the Castle Harbor case is distinguished on its facts due to the differences in the partnership agreements in the two cases. 

The Real Estate Roundtable also filed an amicus brief, which highlights to the court that the recent codification of the economic substance doctrine in Code section 7701(o) places significant pressure on the distinction between, on the one hand, the economic substance doctrine, and on the other hand, substance-over-form and other “soft doctrine” attacks on transactions.  This is due to the strict liability penalty that can apply to transactions that violate the economic substance doctrine.  As the IRS has recognized in recent guidance under section 7701(o), it is necessary for the IRS and courts to carefully distinguish between cases where the economic substance doctrine is “relevant” and those where other judicial doctrines apply.  The Real Estate Round Table then argues that the transaction at issue had economic substance.

The government’s reply brief is due January 31.

Historic Boardwalk – Tax Court opinion

Historic Boardwalk – Government’s Opening Brief

Historic Boardwalk – Taxpayer’s Response Brief

Historic Boardwalk – Amicus Brief of National Trust for Historic Preservation

Historic Boardwalk – Amicus Brief of Real Estate Roundtable

Update on GI Holdings

In our earlier discussion of the disguised sale cases, we noted that the federal district court in New Jersey had issued an unpublished opinion in the GI Holdings case that applied the disguised sale rule of 26 U.S.C. § 707(a)(2)(B) to undo a transaction.  We noted that there was not yet an appealable order in that case, but at some point an appeal to the Third Circuit was possible.  It now appears that the case has been settled and will be formally dismissed in the coming weeks.  Thus, there will be no appeal to the Third Circuit, and the Fourth Circuit’s recent decision in Virginia Historic (see our report here) remains as the sole appellate ruling on disguised sales.

NPR Calendared for Argument

The NPR case (involving penalty application and TEFRA issues in the context of a Son of BOSS transaction: see latest substantive discussion here) has been calendared for argument in New Orleans on December 7th in the East Courtroom.

Bush(un)whacked

The Federal Circuit’s en banc opinion is out.  It affirms the Court of Federal Claims on the reasoning set out in our prior posts and rejects the harmless error analysis of the prior panel opinion.  We are pleased to see the Federal Circuit safely emerge (albeit clutching map and compass) from the TEFRA forest.

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